How To Withdraw Money From Your 401(k)
A 401(k) withdrawal may seem far away when you open the account, but the time comes for everyone. It may happen when you’ve retired or reached a certain age, or it might be when an emergency expense exceeds your other resources.
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If you’re age 59 ½ or older, or you leave or lose your job at age 55 or older (50 for certain public servants), you can withdraw money with no penalty. Otherwise, you’ll have to qualify for a hardship withdrawal or else pay the penalty.
Whatever your circumstances, here’s what you need to know about making a 401(k) withdrawal and how to decide whether it is the right choice.
When Can You Withdraw From Your 401(k) With No Penalty?
In most cases, you can make a 401(k) withdrawal with no tax penalty when you reach age 59 ½. If you leave your job during or after the year you turn 55 — 50 if you’re a federal law enforcement officer, private-sector firefighter or air-traffic controller — you can withdraw from your 401(k) immediately without penalty. However, you will owe income tax on the withdrawal.
If you meet the minimum age requirement, withdrawing is as simple as contacting the company that holds the account to submit a request.
How To Withdraw Money From Your 401(k)
The IRS imposes penalties to discourage 401(k) account holders from using their accounts as ordinary savings vehicles. Unless you qualify for an exception, the IRS will charge a 10% penalty tax on whatever you withdraw before you reach retirement age. Plus, there is a mandatory 20% withholding on any distribution, except for funds rolled over to another retirement account.
That said, not all plans allow for early withdrawal. Check your plan documents to see if it is available. If you can withdraw, find out what requirements you have to fulfill. Here are a few options you might be able to consider.
Hardship Withdrawals
The IRS allows 401(k) account holders to withdraw funds for hardship, which is defined as “an immediate and heavy financial need.”
How Do You Qualify for a Hardship Distribution?
Examples of qualifying financial hardship include the following:
Diagnosis with a terminal illness
Unreimbursed medical expenses above 7.5% of adjusted gross income
Costs related to the purchase of a primary home
Tuition and eligible educational expenses
Foreclosure or eviction avoidance
Home repairs that qualify for a casualty deduction or that occurred in a federally declared disaster area (up to $22,000 per qualified individual)
Personal emergency (once per year, up to the lesser of $1,000 or vested balance over $1,000)
Birth or adoption of a child (up to $5,000 per child for qualified expenses)
Death or disability
Domestic abuse victim (up to the lesser of $10,000 or 50% of account)
Qualified domestic relations order to divide the 401(k) as part of a divorce agreement
Automatic enrollment in the plan
Military reservist called to active duty
In-plan Roth rollover or rollover into an individual retirement account within 60 days of the withdrawal
Always verify your eligibility with a tax professional, as IRS rules may change.
You might still be able to take a hardship withdrawal if you don’t meet the exception requirements. However, you’ll be subject to a 10% tax penalty in addition to the required income tax.
Also, it’s important to know that there are limitations on hardship withdrawals. First, you can’t withdraw more than the amount required to meet the immediate need. Before the distribution can be authorized, you must attest that you can’t meet your need using other resources, such as through insurance or by selling your possessions.
Additionally, you may only withdraw funds from your or your employer’s contributions. You may not withdraw from the account’s investment earnings.
Substantially Equal Periodic Payments
If you have a financial need that doesn’t qualify for a hardship exemption, you may be able to set up a series of substantially equal periodic payments, also known as SoSEPP. SoSEPP payments allow a 401(k) account holder to collect regular payments for life based on their calculated life expectancy.
SoSEPP payments come with several restrictions. For example:
You can take SoSEPP payments only if you no longer work for the sponsoring employer.
You can’t make any changes to the account or take other payments from it.
You can’t change the SoSEPP plan for five years or until you reach age 59 ½, whichever is later, unless you become disabled or in the event of your death.
Consult with a financial professional or plan administrator if you need to set up a SoSEPP for your 401(k). The process is complicated, and penalties can be costly.
How Can I Borrow Money From My 401(k) Without Penalty?
Contact your plan administrator to find out if your plan allows loans. If it does, you might be able to borrow up to $50,000 or 50% of your vested account balance, whichever is less.
401(k) loans work like standard loans in that you are responsible for paying back the borrowed funds with interest. Bear in mind that if you default on the loan, it will be considered a distribution, meaning you could get hit with a penalty for early withdrawal.
If you leave your company, repayment of the balance will be due within a short time, typically less than a year. If you don’t meet the deadline, your loan will be treated as a distribution and be subject to an early withdrawal penalty.
Alternatives to 401(k) Withdrawals
Chances are that you have other options for raising cash besides withdrawing or borrowing money from your 401(k) account.
Take Out a Margin Loan
If you have other investments besides your 401(k), you might be able to borrow money from the brokerage using your portfolio as collateral. According to Charles Schwab, “Margin loans typically require a minimum of $2,000 in cash or marginable securities and generally are limited to 50% of the investments’ value.”
The margin account used for the loan is a line of credit, so you can use your credit line, repay it and then use it again. However, borrowing too much or a loss of your securities’ value could wind up being very costly, Schwab warned.
Borrow Against Your House
A home equity loan or line of credit lets you tap into the equity you’ve built in your home to satisfy larger cash needs.
The loans can be expensive because you’ll pay closing costs and other fees — if the lender claims it’s a no-fee loan, it’ll charge you higher interest to make up for it. And they’re risky because you’ll lose your home if you default. But the interest might be tax deductible, which is a definite benefit for a large loan.
Personal Loan
Personal loans give you access to anywhere from several hundred dollars to six figures, and some lenders’ best rates are comparable to mortgage rates, although you’ll likely need excellent credit and smaller loan amounts to qualify for them.
Deciding When To Make Your 401(k) Withdrawal
It’s always best to keep money in your 401(k) until you reach age 59 ½. Waiting gives your money more time to grow and lets you avoid paying a penalty.
Don’t go straight to an early withdrawal if you need funds. Instead, start with other strategies, such as a personal loan or home equity loan or line of credit.
If you feel you have no other choice but to withdraw, try to take advantage of a penalty-free option, such as the SoSEPP or hardship exemption. Before making a move, speak with a tax advisor to find the best solution.
Daria Uhlig, Vance Cariaga, Kathryn Pomroy and John Csiszar contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: How To Withdraw Money From Your 401(k)
